Does pay for performance work?

Governance experts say that paying competitive salaries for internal staff will have benefits across the entire fund. For some, including those working in public sector pension funds or profit-to-member funds, that is unpalatable. But a comparison of salaries and total investment costs, between two large, different and high profile funds – Ontario Teachers and CalPERS – has got me thinking about what value for members looks like.

The leading institutional investor magazine in Australia, and sister publication of www.top1000funds,com, Investment Magazine, has just published a comprehensive list of salaries of the chief executives, chief investment officers and chairs of the largest 50 funds in that country.

Transparency at this level is new in Australia, and the story has been a topic of much discussion. Who is the highest paid? What is the median and what are the outliers? What are investment staff getting paid for and should more money be managed internally? Do they get paid bonuses, and should they?

Across the board, insourcing asset management at Australian pension funds is quite new relative to how the funds have been managed in the past, and the question of executive pay is hot globally.

Ontario Teachers Pension Plan is considered to be one of, if not the, best pension fund organisations.

It manages the retirement income of 307,000 members and has generated an annualised rate of return of 10.2 per cent since 1990.

The fund manages 80 per cent of the $140 billion in assets in-house, and has 1400 staff.

Talent management is one of the organisations driving tenets, it knows that its people are its best asset.

In the 2013 annual report, chief executive Ron Mock, says: “Teachers’ is known for recruiting and developing smart people, and our employees deserve the credit for our accomplishments. Building internal expertise has been important in lowering costs and being a pension leader. We will stay a step ahead of competitors by giving our young talent exciting development opportunities and recruiting forward-thinking individuals.”

Management of its people comes in a variety of guises including intellectual development and opportunities, but also pay.

The fund’s “compensation philosophy and objectives” have been developed on a foundation of pay-for-performance.

The compensation programs consist of base salary, annual incentives, and long-term incentives and are structured to ensure that there is direct alignment between the total-fund net value added (after expenses) and the compensation paid to senior management.

The philosophy and pay practices are based on the following key objectives:

• attracting and retaining high-calibre employees;

• motivating and rewarding top performance, encouraging teamwork, aligning personal and organizational objectives and rewarding successful performance over the long term;

• targeting total direct compensation (base salary, annual incentive, and long-term incentive allocation) at the median of peers. Exceptional performance at the total-fund, asset-class, divisional and corporate levels will result in top-quartile pay relative to peers, while performance below board-approved financial and operational targets will result in pay below median levels.

All of this means that the senior staff get paid well, very well.

During 2013, salaries, incentives and benefits for the 1,038 employees was $262.1 million.

In his last year as chief executive, Jim Leech, got a base salary of $550,000 and total direct compensation of $8.568 million – which included long-term incentive payments of $6.5 million.

That same year 2013, Neil Petroff, the executive vice president of investments, got paid $4.45 million, including more than half in long-term incentives.

But, and here’s the clincher, the total investment costs of Ontario Teachers’ Pension Plan for 2013 were $364 million or 28 cents per $100 of average net assets. That’s about 28 basis points.

Conversely, the $295 billion CalPERS, which is restricted in what it can pay staff due to its public sector identify, paid $159.3 million in salaries and wages in 2014.

But it spent $1.347 billion in external management fees last financial year. On its current asset size, that’s 45 basis points on external managers only.

In a 2012 cost review CalPERS, identified that $1.15 billion of the $1.26 billion total costs was from external asset management fees, and of that 87 per cent of those external fees were from private assets and hedge funds.

CalPERS, which has a 20-year investment return of 8.5 per cent, has since been recalibrating its portfolio, including its private equity and hedge fund programs, to bring costs down.

But OTPP doesn’t need to compromise investments in potential high-alpha generating investments – 38 per cent of its portfolio is in natural resources, real assets and absolute return strategies, and the 45 per cent in equities is split between public and private markets.

Its internal staff are motivated, professional and are delivering high, consistent returns to members. That’s worth paying for.